The interest rate decisions of the US Federal Reserve (Fed) have far-reaching consequences for global financial markets and the US economy. Since starting to raise rates in 2021 to counter rising inflation, both investors and economists have found themselves caught between market rallies and recession fears. With the latest interest rate cut in 2024, the Fed has made a decisive change of course, bringing both hope and uncertainty to the markets.
This article highlights the complex dynamics between short-term interest rate cuts, long-term risks and political influence on the Fed. It examines how these decisions not only affect economic growth but could also lead to potential financial crises. A deeper insight into the current situation shows why the Fed’s next steps are of great importance for the future of the US economy and global financial markets.
The Fed’s Interest Rate Policy and its Importance for the Markets
The interest rate policy of the US Federal Reserve (Fed) plays a central role in steering the economy and financial markets. Since the beginning of 2021, inflation rates in the US have been rising, prompting the Fed to raise interest rates. This was in response to supply chain disruptions caused by the COVID-19 pandemic and demand fueled by stimulus programs.
US Interest Rate (Source: Tradingeconomics)
Interest rate hikes typically take a year or two to impact the real economy, while financial markets often react immediately. As it happens, stock markets peaked at the end of 2021, when the Fed announced its plans to raise rates, and crashed in 2022, when the rate hikes actually began.
Relationship Between Short and Long Rates
The Federal Reserve has a direct influence on short-term interest rates, but long-term rates, particularly those on US Treasuries, are determined by the market. These long-term rates have a significant impact on borrowing costs, such as mortgages, as many of these debts have a maturity of around ten years.
Interestingly, the US Treasury deliberately lowered long-term rates by the end of 2023 by issuing short-term debt called Treasury Bills. This caused markets to start rising again even though the Fed had paused its rate hikes.
The Rate Reversal and the Threat of a Recession
In 2024, the Fed finally began cutting interest rates by 50 basis points, bringing the key rate down from 5.5% to 5%. This measure is particularly interesting because it shows that the Fed may fear a recession despite falling inflation and a stable unemployment rate. Historically, a recession often occurs shortly after the first interest rate cuts, and there are already some signs that this could be the case this time around.
However, Jerome Powell, the Fed chairman, emphasized in his speech that the interest rate cut was not a sign of an imminent recession. The Fed would continue to adjust its interest rate policy in line with economic data, particularly with regard to unemployment and inflation.
Impact on the Markets
The Fed’s interest rate cut has fueled the markets in the short to medium term, particularly in the areas of small-cap stocks and cryptocurrencies. These asset classes are particularly sensitive to interest rate changes and have benefited from the Fed signals since the beginning of 2024.
However, there is a risk that these interest rate cuts could fuel inflation again in the future. Rising long-term interest rates and the Fed’s ongoing bond sell-off could slow market growth in the long term and lead to renewed market volatility.
Relevant article: How the crypto market would react to the interest rate cut
Political Influences and the Outlook for the US Economy
Although the Fed officially acts as an independent institution, there is always speculation about political influences on its decisions. Particularly before elections, the Fed’s interest rate policy can have a significant impact on the markets, which in turn could influence the political landscape. Jerome Powell has repeatedly emphasized that the Fed acts apolitically, but critics see a possible link to the political environment in the decisions to lower interest rates shortly before the 2024 presidential elections.
The US economy faces an uncertain outlook. While the Fed has cut rates to support the economy, this action could create new issues in the longer term, particularly if inflation rises again or a recession threatens. Markets have reacted positively to the rate cuts in the short term, but risk remains elevated in the long term, especially given the unclear economic and political developments.
Conclusion
The Fed’s recent interest rate cuts are part of a complex economic balance that brings both opportunities and risks. While markets benefit from these measures in the short term, there could be a risk of renewed inflation or recession in the long term. The Fed’s interest rate policy and political influences on markets will continue to be of central importance in the coming years, particularly in the context of the upcoming elections and global economic challenges.
The next few months will be crucial for observing how the US economy develops and whether the Fed is able to strike a balance between combating inflation and avoiding a recession.
Author
Ed Prinz serves as Chairman of https://dltaustria.com, the most renowned non-profit organization in Austria specializing in blockchain technology. DLT Austria is actively involved in the education and promotion of the added value and application possibilities of distributed ledger technology. This is done through educational events, meetups, workshops and open discussions, all in voluntary collaboration with leading industry players.
Disclaimer
This is my personal opinion and not financial advice. For this reason, I cannot guarantee the accuracy of the information in this article. If you are unsure, you should consult a qualified advisor you trust. No guarantees or promises regarding profits are made in this article. All statements in this and other articles are my personal opinion.